The Australian bank appears to have been beaten out by Swissmerchant Mercuria in the closely watched sale of JPMorgan Chase& Co's physical commodities unit, the biggest suchbusiness on Wall Street and a potentially transformative dealfor Macquarie.

The setback is at least the second time in five years thatMacquarie has looked at expanding the business by buyingphysical commodity assets from other banks. In 2010, the bankexpressed interest in the physical metals business being sold bythe Royal Bank of Scotland due to European Unionregulatory pressure, sources said at the time. Ultimately,JPMorgan bought it.

The loss also comes toward the end of a series of deals thathave transformed the commodity trading landscape, withmerchants, private equity groups and less-regulated foreignbanks like Macquarie picking up the slack left by Wall Street'swithdrawal under unprecedented regulatory and politicalscrutiny.

A host of other trading desks have also been sold over thepast few years, including Morgan Stanley's physical oildivision and the energy unit of agricultural trader Gavilon. Itis not clear how closely Macquarie examined these businesseswhen they were put on the block.

Macquarie has grown its commodity trading business through ahandful of bite-sized U.S. acquisitions, and as recently asNovember executives said they were still looking to expand, boththrough self-funded growth initiatives and acquisitions.

But its absence from the list of recent deals may raisequestions about how it will achieve the critical mass tochallenge expanding giants such as Mercuria, or even remainingWall Street titans Goldman Sachs and Morgan Stanley.

"The question is whether they are going to be able to findthose kinds of assets and be the winner in the sort ofcompetition against a bidder like Mercuria," said Craig Pirrong,professor of finance at the University of Houston.

A Macquarie spokeswoman declined to comment.

It is unclear whether Macquarie will be interested in othercommodity assets that could be up for sale.

Goldman Sachs has said it may look to divest Metro, whichlike JPMorgan's Henry Bath division, is a part of the LondonMetal Exchange's (LME) vast warehouse network.

A year ago, Macquarie bought a stake in Scale Distribution,a small UK-based storage firm that has registered LME warehousesin Liverpool, Detroit in Michigan, and Panama City in Florida.

Hess Corp. is still working to sell its 50 percentshare of the Hetco trading group, an asset-light proprietarytrader that may not suit the more risk-averse Australian group.

DEALS, BUT SMALL

Macquarie started small, buying a natural gas trading desk,Cook Inlet Energy Supply, in 2005, and followed that with alarger deal for Constellation Energy's downstream natural gastrading operations in 2009. It began trading physical power in2007 and, eventually, physical oil in 2010.

Macquarie executives often refer to it as an "adjacent"expansion strategy: buying businesses they're already familiarwith, if and when the opportunity becomes available.

Over the last decade, the business has become increasinglyimportant to the Australian banking group's fixed income,currency and commodities (FICO) division, which now generatessome 60 percent of its operating income from commodity markets,according to a recent management presentation.

"It actually looks quite different from most of the globals'FICC business in that we've got a much stronger focus on thingslike resources and commodities ... we're working in those nicheswhere we've been able to establish clear expertise andprofitability," Chief Executive Nicholas Moore said in anearnings call last May.

Combined with the bank's non-merger related growth efforts,Macquarie's Americas FICC staff grew from 19 people in 2004 toabout 440 as of last year. Most of that growth occurred in theHouston-based energy markets division, led by Nick O'Kane.

Macquarie also has an advantage over most other big globalinvestment banks, many of which are either getting out of orsteering clear of commodities. It has opted not to operate as acommercial bank in the United States, remaining outside theremit of the Federal Reserve and other U.S. banking regulatorsthat have been pressuring banks to exit the business.

And yet, a transformative acquisition, like JPMorgan's 2010Sempra purchase, has so far eluded the bank. That could be afunction of the sheer size of the assets up for sale.

Macquarie's net income from commodity trading in the 12months ending last March exceeded $700 million for the firsttime. By contrast, in documents circulated to potential buyers,JPMorgan generated an annual income of $750 million off itscommodity assets, which it valued at $3.3 billion.

For a bank like Macquarie with a physical commoditypresence, there would also be some overlap, some say.

"I think there may be less duplication with the Mercuriapeople than the Macquarie people. That's why I think they(Mercuria) are still in the running," said Edward Meir, seniorcommodity consultant at brokerage INTL FCStone in New York.

(Reporting By Cezary Podkul; Editing by Jonathan Leff and AldenBentley)